Yesterday, June 23, 2016, the OCC held a forum on "responsible innovation" as part of the agency's ongoing dialog with the banking and FinTech industries. The forum followed the OCC's release in March of a white paper on innovation in the banking industry and a subsequent comment period that ended on May 31.
The broad lesson of the forum is that FinTech is now squarely in the sights of the federal and state regulators. Other lessons were more tentative although four recommendations for community banks became evident. Apart from a description of next steps in addressing responsible innovation, the OCC did not announce any decisions. Still, comments during the day from both the agency and private sector panelists suggest some considerations that both banks and FinTech companies should take into account.
This alert addresses first the OCC's approach to innovation in banking and then turns to recommendations for community banks and other messages that emerged from the forum.
The OCC's Next Step
The OCC begins with its definition of "responsible innovation":
The use of new or improved financial products, services, and processes to meet the evolving needs of consumers, businesses, and communities in a manner that is consistent with sound risk management and is aligned with the bank’s overall business strategy.
This definition may in fact be too narrow; the forum covered shadow banking – the offering of bank-like products and services outside a banking organization – as one aspect of innovation to be addressed. With this starting point, the OCC is now beginning to address specific issues.
- A new working group. The Comptroller announced the formation of a new working group to make "operational" within the OCC the eight principles stated in the OCC's white paper. The group plans to undertake five matters:
- Development of options for the OCC's organizational structure in regulating innovation.
- Establishment of a timely and transparent decisionmaking process at the agency.
- Development of a formal outreach program to all stakeholders in innovative banking, not merely national banks and federal thrifts.
- Fostering an internal culture more receptive to responsible innovation.
- Collaboration with other regulators.
- A new limited purpose charter. The agency has created a separate working group to analyze a new charter for FinTech companies that might wish to operate as banks. Federal preemption would be the chief advantage. The possibility of such a charter raises a large number of issues, including the criteria for granting a charter, the application of CRA, deposit insurance, and conservatorships and receiverships of failed limited purpose companies.
Because success in FinTech typically requires a significant upfront investment and scalability, community banks might find themselves at a disadvantage. To avoid this result, community banks should consider the following:
- Partnering. While community banks are familiar with the use of third-party vendors, the advent of new technology will require new and closer partnerships with FinTech companies. Banks should begin to consider how they might structure such partnerships. The OCC and the other banking agencies have not released any guidance on partnerships; the most recent guidance from the OCC is a 2013 bulletin on third-party relationships.
- Specific technology strategy. Not all bank business plans now address technology as a separate matter, but with the growth of new technology, banks should address this subject specifically. The regulators currently have no such requirement, but one can foresee such a requirement.
- An app store for community banks. Community banks typically lack the internal resources to develop their own software, and the creation of an app store may be an appropriate response. Of course, such a store likely would be the product of a FinTech company (rather than a bank or even a group of banks), but banks may wish to encourage this opportunity.
- Technology-related services not previously provided. A partnership or an app might enable a small bank to offer services, such as money transfers, that a customer previously could obtain only at a large bank. A community bank should consider its options here.
- Overall regulatory framework. The regulation of FinTech in connection with the banking industry involves issues outside the bailiwick of the OCC on a national level and even an international level. The need for U.S. regulators to create a regime with a single body ultimately directing oversight was discussed. FFIEC was cited as a possible model. Panelists also contrasted the current disparate approach of U.S. regulators with the focused strategy in the U.K. of becoming the hub of financial innovation.
- Risk tolerances. A fundamental challenge to the oversight of FinTech companies by bank regulators is the dramatically higher tolerance for risk in those companies. Investors are willing to invest in many FinTech companies, expecting a few but substantial successes and a relatively large number of failures. By contrast, banking firms run themselves and bank regulators supervise them in a highly risk-averse way where any failure is unacceptable. Whether and how a bank regulator can accept the greater risks inherent in FinTech remains to be seen.
- Banking through smart phones. Smart phones are becoming the preferred vehicle for banking, and there was a prediction that virtually all U.S. adults would bank by phone in the early 2020s. The OCC and the other banking agencies recognize smart-phone banking as a means for financial inclusion of the underbanked, but no regulations or guidance have yet taken shape.
- Systemic risk. On a number of occasions, panelists referred to the Financial Stability Oversight Council's 2016 annual report, which was released earlier this week. The report contained an assessment of financial innovation. This discussion raised some concerns in the private sector about systemic risk regulation, although many discounted the discussion as one dealing only with potential threats.